The UK’s Government Debt since WW2
Simon Wren-Lewis has written an interesting post on the fiscal record of the last government and Hopi Sen has written an equally interesting response. I’d recommend a look at both.
Simon criticises a recent article from the FT’s Janan Ganesh which argued that:
Of course, the fiscal crisis is mostly the result of the financial crisis. But it is worse than it should have been because of the prior failure to build surpluses, or at least run balanced budgets
To which Hopi writes:
This doesn’t seem to me to be inconsistent with Wren Lewis’s own view that it would have been better if Labour had held the debt-to-GDP ratio at the 2002 level.
I’m not so sure.
Indeed I find much of the focus of the current fiscal debate on running balanced budgets or/and surpluses to be quite misplaced.
To explain why (and this will surprise no one) I’ll use some charts. All of the data in the following three charts is straight from the IFS’s excellent ‘Fiscal facts’ series.
First, the chart below shows public sector net borrowing (PSNB) (as a % of GDP) from 1948/49 to 2011/12.
A negative number means a surplus, a positive number means a deficit. The chart below shows the spikes in borrowing that accompanied recessions in the 200s, the 1990s, the 1980s, and the 1970s very clearly.
But perhaps what is more interesting, is the lack of surpluses. Indeed in only 18 of the 63 years below was there a budget surplus. Over the whole period the average PSNB was a deficit of 2.4% of GDP. Even excluding 1973-76, 1979-83, 1990-1993 and the period from 2008 onwards (all periods when GDP was below its previous peak) we still find an average deficit of 1.5% of GDP.
In other words, running a deficit is the norm.
Which is what makes the chart below so interesting it shows public sector net debt to GDP over the same period ()actually the National Debt to GDP until 1975).
As can be very clearly seen, the longer term trend has been for a falling debt/GDP ratio.
Finally, below I’ve put the two charts together.
The point I have been coming to, in an admittedly rather roundabout manner, is this: deficits are compatible with a falling debt/GDP ratio.
For example, from 1971/72 all the way until 1988/89 the UK government never ran a surplus. And yet debt/GDP over the same period fell from 60.0% to 36.6%.
To understand how this happens we need to look at debt dynamics, and the best guide here comes from an Economist blog post of 2011. In reality, getting debt/GDP down is not just about running surpluses (as demonstrated by the UK’s post-war experience) but is governed by a combination of interest rates, inflation, GDP growth and the primary budget balance (i.e. before interest rates).
The Economist piece linked to above as a handy calculator (admittedly with some data now slightly out of date). If one holds interest rates constant at 3.0% and inflation at 2.0%, then a UK which has growth of 2.5% and 1.0% primary deficit, has a lower debt/GDP ratio in 2020 than a UK which has primary balance but growth of only 1.0%. In other words there are circumstances in which GDP growth is a better way of reducing debt/GDP than running a balanced budget.
The point of this post is not rehash the arguments about fiscal policy pre-crash (again I’d recommend the two blogs linked to at the beginning of this post) but to note that when debating future fiscal rules it is important not to fetishise the idea of a surplus. There are circumstances in which a surplus is required to reduce debt/GDP, but there are also many times when it is not.
End note: On a broader point, it would be very silly to look at the UK’s experience of reducing post-war debt/GDP from circa 220% to circa 50% from the late 1940s to the mid 1970s without considering the role of ‘financial repression’. The best single paper here is from Reinhart & Sbrancia. As noted above both the interest rate on government debt and the level of inflation are crucial to understanding the path of the debt/GDP ratio, by ensuring interest rates are below inflation and pushing domestic financial institutions into holding government debt, government’s can reduce the debt/GDP ratio.The paper linked to above notes that:
“For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during 1945-1980. For the United States and the United Kingdom our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 3 to 4 percent of GDP a year.”
It is also worth noting that “financial repression” is quite a pejorative term – maybe a better one would be “successful debt management policies”.